2.) Cost Concepts

Question 1

What is Cost Classification?

Answer 1

• Grouping together costs which share the same attribute(s), relative to a stated cost objective
• Cost objective (purpose of) determines the classification to be used
• Changing the cost objective may alter the categorisation of a specific cost within a given classification

Question 2

What is the difference between a Cost Objective and a Cost Object?

Answer 2

Cost Objective:
- Any activity for which a separate measurement of costs is required

Cost Object:

• “Anything for which cost data are desired”
• Units of product/service
• Organisational departments/sections

Question 3

List some examples of Cost Objectives and Cost Classifications.

Answer 3

Cost Objectives:

1) Assigning costs to cost objects; traceability (direct or indirect)
2) Financial reporting; inventoriable or expensed (product or period)
3) Predicting cost behaviour in response to changes in activity (fixed or variable)

Cost Classifications:

4) Assessing performance (controllable or uncontrollable; if costs can’t be controlled, then the managers can’t be very motivational to staff)
5) Making decisions (differential, sunk, opportunity)

Question 4

How do Retailing and Manufacturing activities contrast re. cost objects?

Answer 4

Retailers:

• Buy finished goods
• Sell finished goods

Manufacturers (produce something from bought in goods):

• Buy raw materials
• Produce and sell finished goods

Question 5

How do Manufacturers and Services differ?

Answer 5

• Similar in that they both produce something

- But differ in that Services are perishable; cannot be stored for later use etc.

Question 6

What cost objects do manufacturers incur? What is their inventory like?

Answer 6

Design and manufacture products for sale:

1) Must accumulate costs of manufacturing products
2) Inventory consists of materials, WIP (work in progress), and finished goods (FG).

Question 7

What cost objects do retailers incur? What is their inventory like?

Answer 7

Purchase goods already manufactured, resell them:

1) They accumulate the purchased costs of goods only (rather than the cost of manufacturing products)
2) They only have one type of inventory (merchandise inventory)

Question 8

What do both Manufacturers and Retailers report re. cost objects?

Answer 8

• The cost of unsold goods on the balance sheet/Statement of Financial Position (SoFP) AKA balance sheet
• Cost of goods sold on the statement of profit or loss (P/L sheet)

Question 9

How is Cost of Sales calculated? Where is it submitted?

Answer 9

> (Opening inventory + Purchases) - Closing Inventory = Cost of Sales
Submitted on Profit & Loss sheet

Question 10

What is meant by Closing Inventory?

Answer 10

Any stock not sold.

Question 11

How do Cost Objects in Manufacturing differ WRT inventory compared to Retail?

Answer 11

• Manufacturing includes materials, WIP and FG inventory, whereas Retail only has FG to form their Closing Inventory
• Thus there would be leftover in materials/WIP irl as well as FG in Manufacturing; all would go onto the Statement of Financial Position (SoFP) AKA balance sheet

Question 12

How does the focus of Manufacturing Cost differ from Financial Accounting to Management Accounting?

Answer 12

Financial Accounting:
- Cost is a measure of resources used or given up to achieve a stated purpose

Management Accounting:

• Products costs are the costs a company assigns to units produced
• Focus in product costs rather than financial statement costs

Question 13

What different Manufacturing Costs are there to making a product?

Answer 13

• Direct Materials
• Direct Labour
• Manufacturing Overhead

Question 14

What are Direct Materials?

Answer 14

• Materials that become an integral part of the product
• Can be easily traced to the product (traceability makes it a Direct Material cost; w/o, it would be an Indirect Material)
• E.g. a car radio (easily traceable to the end product, is a complete thing, easy to trace)

Question 15

What is Direct Labour?

Answer 15

• Labour costs that can be easily traced to individual units of product
• “Touch Labour”
• E.g. wages paid to assembly workers; direct labour costs calculated via observation of workers, measuring what each person is doing etc.

Question 16

What is meant by the Manufacturing Overhead?

Answer 16

> Costs that do not exist w/o production itself
Costs can’t be traced directly to product

Indirect labour:

• Wages paid to employees who are not directly involved in production work (factory labour other than the workers that actually transform raw materials to FG)
• E.g. Maintenance workers, supervisors and security guards

Indirect materials:

• Materials used to support the production process; something directly used, necessary for production e.g. glue
• E.g. lubricants, cleaning supplies used in the car assembly factory (too insignificant to become a direct cost)

Question 17

What is the Total cost comprised of?

Answer 17

• Direct costs; attributable to a single cost object (traceable to the product being produced)
• Indirect costs; attributable to 2 or more cost objects (common to all products e.g. overheads)

Question 18

What terms describe the combination of different manufacturing costs?

Answer 18

Prime Cost:
> Direct Materials + Direct Labour

Conversion Cost:
> Direct Labour + Manufacturing Overhead
(‘converts’ raw materials into the product)

Question 19

What Nonmanufacturing Costs are there?

Answer 19

Marketing and selling costs:
- Costs necessary to get the order and deliver the product

Administrative costs:
- Executive, organisational and clerical costs that cannot be reasonably assigned to manufacturing or marketing (nothing to do w/production function)

Question 20

How do Nonmanufacturing Costs differ from Manufacturing Costs?

Answer 20

• Nonmanufacturing Costs do not add any value to a product
• NCs are not incurred when a product is stored
  »> Thus NCs not included in balance sheet of unsold product (Closing Inventory)

Question 21

How do Product Costs differ from Period Costs?

Answer 21

Product Costs:

• Direct materials & labour, Manufacturing Overhead
• Closing Inventory reported on Balance Sheet (SoFP) AKA balance sheet
• But upon Sale, this Product Cost would be become Cost of Good Sold, reported on Statement of P/L

Period Costs:

• Anything not a Product Cost
• Just is an ‘Expense’, documented in P/L account (Statement of P/L)
• Period Costs have to be deducted (an expense) to calculate Net Profit

Question 22

Describe what a Statement of Financial Position would have on it (Retail or Manufacturing).

Answer 22

Currents Assets:

• Cash
• Debtors (people who owe you money; are an asset)
• Prepayments; e.g. insurance for 2 years, year not yet used is on balance sheet
• Inventory (cost of unsold goods; inc. raw, WIP and FG in Manufacturing)

Question 23

Describe what a Statement of Profit/Loss would include.

Answer 23

> Opening inventory
\+ Purchases/Cost of Goods Manufactured 
> Goods availible
- Closing inventory
> Cost of goods sold (needed for P/L account; this is just a P/L statement as there is no revenue stated here)

Question 24

What are the costs of manufactured goods, their corresponding balance sheet inventory variables and the resulting P/L account expenses?

Answer 24

Costs:

• Material purchases
• Direct labour
• Manufacturing overhead (conversion cost w/D.L.)
• Selling and administrative (nonmanufacturing)

Balance sheet/SoFP:

• Raw materials (material purchases)
• WIP goods (direct labour/overheads)
• Finished goods
• Period costs (selling + admin)

P/L account expenses:

• Cost of goods sold (fin. goods)
• Selling + admin

Question 25

How do product and period costs differ re. when they are submitted to the P/L statement?

Answer 25

Product costs:

• Go into balance sheet (SoFP) as assets
• Then only go on P/L statement when they exit the business; when the product is sold

Period costs:

• Go through P/L statement in the period in which they are incurred
• Not necessarily when they are paid e.g. 2-year insurance policy

Question 26

What is the difference between differential revenue and differential cost?

Answer 26

Differential revenue:

• Difference in revenue when costs incurred to achieve new revenue are not considered
• Bare difference figure e.g. £1,500 vs. £2,000 a month salary = £500 diff. revenue

Differential cost:

• The sum incurred cost of achieving new revenue
• E.g. If it would cost £300 a month to commute to the new £2000 per month job, the differential cost is £300 (where the Net profit/gain is £200 as a result)
• The bare cost of doing another ting

Question 27

What are Opportunity Costs?

Answer 27

• Potential benefit that is given up when one alternative is selected over another; ‘sacrifice’
• Cost of benefit that is given up
• E.g. if not attending UNAY, could be earning £15,000 P.A. thus opportunity cost for attending UNAY is £15,000 for one year.

Question 28

When is Opportunity Cost relevant?

Answer 28

• Only relevant when there are scarce resources availible; what you’re giving up to do the other thing
• E.g. could go to UNAY and earn £15,000 too, but time is a scarce resource

Question 29

Define: Sunk Costs.

Answer 29

• Costs that cannot be changed by any decision; they have already occurred, and cannot be recovered
• They are not differential costs and should be ignored when making decisions
• E.g. buying a car that cost £10,000 two years ago; £10,000 is sunk whether it is driven, parked, traded etc. - cannot change the OG £10,000 initial cost.